Wholesale shock looms: Peering into the 2028 market

Inventory constraints in the new-vehicle market are poised to ripple across the wholesale market in the next few years, likely keeping used-car prices elevated through 2027, though a looming recession and the uncertain return of vehicle supply present a range of long-term scenarios. 

New-unit factory output may not reach normal capacity until 2025, Jonathan Smoke, chief economist at Cox Automotive, said during the Manheim quarterly call on July 8. By 2027 or 2028, those supply chain constraints should begin to affect wholesale values.  

“The wholesale market suffers when the new-vehicle market has a big decline like it’s had. It’s two to three years after the fact that the wholesale market is the tightest, and we’re right now at the beginning of that stretch,” Smoke said. “We’re not going to have conditions that really create the likelihood of a major decline in values beyond what normal depreciation is going to deliver because supply is very constrained.” 

New-vehicle inventory sat just above 30 days’ supply in June, according to Cox Auto. This is down from an industry norm of 60 days. Due to tight supply, Cox Auto projected in June that the new-vehicle seasonally adjusted annualized rate (SAAR) will finish the year at 14.4 million units, down from an initial forecast of 16 million units earlier this year.  

At the same time, used-vehicle values reached record levels following the onset of the COVID-19 pandemic and have continued to fluctuate above normal levels amid inventory constraints and economic uncertainty. The Manheim Used-Vehicle Value Index in June dipped 1.3% month over month to 219.9, however it was up 9.7% year over year. In May, the index increased 0.7% MoM on the heels of sequential declines in February, March and April.  

Data from Moody’s Analytics points to similar trends in used-vehicle values. Through the end of June, the Moody’s Analytics Used-Vehicle Price Index fell 6.1% to 235 from a peak of about 250 in the beginning of the year, marking the first time used-vehicle prices posted a negative quarter in more than a year, according to Moody’s Q2 used-vehicle price report. During the previous five quarters, the index showed the largest consecutive gains in seasonally adjusted prices in two decades.  

“We don’t expect there to be any sort of coming back down to where we would have been if we had normal 2% price appreciation in terms of auction wholesale prices, but I do expect there to be some meeting in the middle between new and used prices,” Mike Brisson, senior economist at Moody’s, told Auto Finance News, noting Moody’s expects the price index to come down about 15% by 2024 as supply rebuilds.  

The future of pricing 

While multiple analyses show similar used-vehicle value shifts, views are mixed on pricing trends looking out five to six years.  

“The thing that destroys used-car values is excess production of new cars,” Thomas King, chief product officer and president of JD Power’s data and analytics division, said July 26 at the Origence Lending Tech Live Conference in Aurora, Colo. “This production disruption has been going on for long enough that we are now going to be entering a window where we will have materially fewer used cars. The supply of one-, two- or three-year-old vehicles is going to be compressed. We expect used-vehicle values to stay robust.” 

Depreciation of used-vehicle values will also likely be limited in the long term due to the wholesale market’s impact on used-vehicle pricing, Smoke told AFN, noting the industry is in the early stages of a contraction in volumes following an unprecedented reduction in new-vehicle production and sales. 

“We’ve yet to reach the bottom of the new-vehicle production decline, so that means we’re very supply constrained in wholesale, and that will continue for at least the next three years,” Smoke said. “Usually, that means wholesale values are more likely to go up rather than down and hold their value over the next several years.” 

Further, declines in leasing and fleet sales in the past two years have contributed to inventory shortages and higher prices in the used market. The ebbs and flows of commercial vehicles at auction largely drive wholesale market changes and impact how vehicle values trend, Smoke said.  

Wholesale changes “are mainly driven by leased vehicles and vehicles that are a part of fleets, and those happen to be the two components of new-vehicle production and sales that have declined the most and have yet to show any evidence of having reached bottom,” he said. “At least through 2024, we’re still going to be substantially tighter than what we were in 2019. I wouldn’t say it creates an environment where you’re necessarily going to see further price appreciation, but it puts a floor under what pricing could do.” 

Moody’s, however, predicts that used-vehicle values will continue to soften as new-vehicle inventory improves, according to its Q2 report. Moody’s “optimistic” projections assume new-vehicle production will return to pre-pandemic levels by early 2023, and that used-vehicle prices will remain relatively flat for the rest of 2022, Moody’s Brisson told AFN. 

“Assuming that production comes back by the end of 2022 — so supply picks up and inventory starts to rise towards more historic levels — I don’t see that the lack of sales in the past couple of years is going to significantly impact 2027 and 2028,” he said. “Long term, if there’s profits to be made, you can increase production in the new-vehicle space, and new-vehicle prices can rise to take off that froth from used vehicles.” 

Corrections to leasing and fleet sales are also expected long term, Brisson added. Fleet buyers, for one, may start buying more new vehicles instead of going to the used market.  

Fleet companies “will have a higher percentage of new-vehicle sales, which means that they’re going to have more coming off fleet each year if they’re able to get better deals [by 2028],” Brisson said. “If the market does end up correcting, I don’t see there being a huge impact on prices over the long term. But that assumes everything straightens out over the next couple of years.” 

Recession on the horizon? 

The auto industry is also preparing for a potential recession after the Federal Reserve on July 27 raised interest rates by 75 basis points for the second consecutive month in an effort to curb rampant inflation, bringing the target rate range to 2.25% to 2.5%. 

Still, conditions are unlikely to deteriorate to the point of meaningful vehicle value declines, Smoke told AFN.  

“Historically, when you’ve had declines in values, it’s typically been when we’ve had a recession and demand is cut,” he said. “But every other recession historically had excess supply building up before we entered the recession, and we clearly have an absence of that.  

“There’s very limited risk of a price correction,” Smoke added. “It would take a recession that dramatically reduces consumer demand, and even those who are saying that we are likely to enter a recession are not expecting this type of recession to be one that produces massive job losses that historically have been related with big declines in vehicle demand.” 

Moody’s, too, predicts interest rate increases will help cool inflation, but not enough to send the economy into a recession, according to the Q2 report. “We have probably some of the most optimistic projections in the industry right now in terms of the [federal government] being able to thread the needle [on inflation] and slowing down growth,” Brisson told AFN, noting unemployment was just 3.6% in June and consumer savings rates are at record highs.  

Even with efforts to slow inflation, and even if the used-vehicle market continues to depreciate to normal levels, new-vehicle prices will remain “abnormally high” in the long term. Supply will take years to refill, and consumers will continue to pay above manufacturer’s suggested retail price (MSRP) for new cars as demand remains strong, Smoke told AFN.  

“We’re looking at a horizon where new-vehicle prices are going to be going up at a historically higher rate because of the increased cost of labor, the increased cost of the materials that go into vehicles and the move to electrification,” he said, noting vehicles will likely depreciate less over time. 

“We were already seeing new-vehicle prices go up at a higher pace historically prior to the pandemic,” Smoke said. “All of those things suggests that vehicle values are going to hold up.”  

Auto Finance Summit, the premier industry event for auto lending and leasing, returns October 26-28 at the Wynn Las Vegas. To learn more about the 2022 event and register, visit www.AutoFinanceSummit.com.